What’s driving Japan’s market?

By Joss Murphy on 2 September 2026 in Asia/Emerging Markets

The best-performing developed market this year is, perhaps surprisingly, Japan. In fact, in spite of the astonishing run in US and Asian technology companies, Japan is also one of the top-performing developed market sectors over three years*. A combination of corporate governance reform, strong earnings and economic revival have seen its markets turn higher.

However, there has been some odd activity going on more recently. In July, the US stepped in to support the yen in a coordinated move with the Japanese Ministry of Finance. It was the first US-Japan joint operation to buy the yen since 1998. This historic intervention looks like an emergency measure and could be unsettling for investors.

Why did they do it? The accepted view is that it would stabilise the Japanese currency, which has been declining since 2012. It has fallen particularly hard since 2020 and has continued to slump even as interest rates and inflation in Japan have risen. This bothers the US: a weaker currency makes Japanese exports cheaper and therefore threatens US manufacturing.

Yen weakness may also threaten broader economic stability across Asia. US Treasury secretary Scott Bessent said part of the US motivation in intervention was to prevent a severe currency crisis like the one seen in the late 1990s. He said a weaker yen could pressure other countries in the region to devalue their currencies, such as the South Korean won or Chinese yuan.

There is also the hope that it might help stabilise US borrowing costs. The Japanese are the largest foreign owner of US treasuries. The US has been persistently worried that higher interest rates in Japan might prompt a significant repatriation of capital from the US to Japanese bonds. The hope is that the intervention may deter international investors, including the Japanese themselves, from selling US government bonds to raise dollars to support the yen.

This may seem like the rarified workings of a central bank with little impact for investors, but the highs and lows of the yen have influenced the type of companies that have done well in Japan. A weak yen flatters the exporters that dominate the major indices. These exporters have also been the strongest beneficiaries of the corporate governance reforms in Japan, pushed to reduce their cash balances and improve return on equity. Value stocks have outpaced other parts of the index and most of the top-performing funds in the sector over three years have a value tilt**.

The rise of AI

More recently, however, there has been another factor for investors to worry about. Japan has experienced a similar phenomenon to the US and Taiwan/South Korean markets, where market leadership has become dominated by the AI trade to the exclusion of other areas. Many of these are also exporters.

Carl Vine, manager of the M&G Japan fund, says: “AI-linked companies now account for roughly a quarter of the Japanese benchmark. In parts of the market, price action has become extreme, with moves that once represented a solid annual return now compressed into days or weeks.”

He points to Kioxia, a computer memory manufacturer, as the most striking example. “Listed only 18 months ago, at a market capitalisation of a few billion dollars, at one point during the quarter Kioxia surpassed Toyota to become Japan’s largest company by market capitalisation, while reaching around 7% of our small-cap benchmark and 4% of the MSCI Japan Index.”

This AI focus has seen different types of funds come to the fore. The growth-focused Baillie Gifford Japan Trust, for example, is top quartile over three and six months**. Manager Matthew Brett says companies focused on automation, robotics, and semiconductor supply chains have seen sustained demand, benefiting from global tech trends and capital expenditure cycles. “This backdrop, although narrow in terms of market returns, has been supportive for the portfolio.”

“Toyota, for decades the country’s undisputed corporate heavyweight, its largest company and most recognised brand, relinquished the top spot – first to SoftBank and then to memory-chip maker Kioxia.” While the fund doesn’t own Kioxia, it does have a position in SoftBank, the portfolio’s largest position***, which has large ownership positions in ARM and OpenAI, among others.

The problem is that while markets have been focused on the beneficiaries of a weak yen, or the AI trade, they may be missing opportunities elsewhere. Vine says: “The amount of oxygen AI is taking out of the room is masking, and perhaps even creating, opportunity elsewhere. The corporate change dynamic in Japan has not stopped; if anything, it continues to broaden.”

Brett points to automation companies Yaskawa, Fanuc and Harmonic Drive “all exposed to the longer-term need for greater productivity, especially in a country facing labour shortages and rising wages. These companies are seeing record orders, larger backlogs and better-than-expected earnings.”

Until recently, smaller companies had also been widely neglected by the market, which had been a problem for many active managers. However, they have been edging higher in the short term. For example, the M&G Japan Smaller Companies fund is in the top 10 performers over one year**. While the MSCI Japan Small Cap index still lags over one year, it is marginally higher than the MSCI Japan for the year to date****.

It is possible that smaller companies will be the beneficiaries of the next wave of corporate governance reform. Active managers suggest that they could be beneficiaries of increasing merger and acquisition activity, but also the drive for more efficient balance sheet management. They are more domestic in focus and may therefore benefit from a stabilisation in the yen.

Vine says: “In a market where the loudest narrative is increasingly concentrated in a handful of semiconductor-linked stocks, the more interesting opportunities may be in quieter parts of the market where corporate behaviour is changing, expectations are less crowded and the price signal is less distorted by thematic urgency.”

The Japanese market has disparate forces tugging it in different directions. For investors, it argues for a flexible approach to investment in Japan, rather than a dogmatic adherence to a single style.

*Source: FE Analytics, total returns in pounds sterling, to 31 August 2026

**Source: FE fundinfo, at 31 August 2026

***Source: fund factsheet, 31 July 2026

****Source: index factsheet, 31 July 2026